[Biotech background articles - continued] FYI Scott
Here's How To Play Those Hot Biotech Stocks.
by Stephen Northfield
Globe and Mail "Investing", November 16, 1996
So maybe you missed out on Biovail Corp., and BioChem Pharma Inc., the Bre-X Minerals of the biotechnology world. All is not lost. While the biotechnology market is a little
overheated at the moment, there are investment opportunities out there. The trick, obviously, is to find them.
Here are a few rules to help reduce the risks and boost the potential rewards of investing in biotech stocks:
Avoid the one-trick pony
On Feb. 22, 1993, Synergen Inc. stock plummeted $26.62 (US) to $13.50 after releasing dismal clinical results for its flagship prospect Sepsis, a drug to fight blood infections. The
lesson: Avoid the one-trick ponies unless you're very certain they can get past the finish line.
Look for companies with at least two drugs in clinical trials. That way if one flames out, there's something to fall back on.
An even better approach is to look for companies diversified around a specific disease class or that have a niche technology that can be used as a platform for a range of different drugs.
Two examples: Toronto Stock Exchange-listed Micrologix Biotech Inc., which has developed a method of producing bacteria-fighting peptides; and Synsorb Biotech Inc., which has a
technology to develop drugs to treat infections.
Know who is running the show.
"I'd be careful with the genius scientist who starts a company without knowing what the market is looking for," says Bin Huang, analyst with Griffiths McBurney & Partners. Look for the
presence in senior management of someone with a proven track record of taking a drug through the regulatory hurdles and/or to the marketplace, although that may not always be a
realistic condition with early-phase companies.
"I want to see a guy who has succeeded," say a long-time industry watcher Evan Sturza, editor of Sturza's Medical Investments News Letter in New York. "It's not that hard: you simply
look at a prospectus and go through the section on management to see who's working there and what they've done in the past."
Don't forget the patent.
Patent disputes can turn a nice story into a nightmare. Just ask BioChem Pharma, now fighting a rear-guard action against Emory University in Atlanta, which was awarded a U.S. patent
for BioChem's flagship 3TC AIDS drug. While most observers expect BioChem to prevail, uncertainty will be the order of the day until the issue is put to rest.
Ideally, look for patents covering core technology and major products. Check the prospectus for references to any simmering patent disputes. Patents aren't the whole story. High
barriers to entry -- costs or a big head start in research -- can often be just as good.
Joining the A team.
No one can match the due diligence of a heavy hitter like SmithKline Beecham PLC or Glaxo Wellcome PLC. When one of these pharmaceutical behemoths enters into an alliance with
a development phase biotechnology company, it means that some of the best minds in the business are giving a thumbs up to what's brewing in the lab.
Be suspicious of companies that are well into clinical trials without securing a marketing or research partner, a sign that the drug's commercial prospects may be limited. Look for
substantial milestone payments and cash commitments when the deal is announced, not just nebulous talk about a research alliance.
One caveat: Risk-oriented investors looking for big returns may not want to wait until a deal has been struck, said Yorkton Securities Inc. analyst Ezra Lwowski. Biotechnology stocks
tend to make big moves on news of significant alliance with a pharmaceutical company. So, while the deal may remove a lot of risk from the investment, investors will also miss out on the
biggest part of a stock's gains. A good example of BioChem Pharma. Glaxo licensed BioChem 's 3TC in 1990, very early on in the drug development. That was taken as a strong signal
that the drug had blockbuster potential, driving the shares up sharply.
The easy money in BioChem was made in 1990 (up 113 per cent) and 1991 (up 279 per cent). The stock then languished until last year, when it rose sharply ahead of the U.S. Food
and Drug Administration's approval of 3TC in November, 1995. It has done little since then.
Watch the piggy bank.
It takes cash and lots of it to keep the Bunsen burners going. Look for companies that have a minimum of two years' cash reserves. Twelve months or less and alarm bells should be
going off. (Most companies make public their monthly rate of cash burn.)
While financing has been easy to come by in the past two years, historically there have been regular dry periods that last or several years. Some analysts think the financing window may
now be closing. Cash strapped companies are in a weak bargaining position with potential strategic partners and investments bankers.
Big is beautiful but niche is nice too.
If you're going to roll the dice in the biotechnology game, you might as well go for the big score. Mr. Sturza looks for companies developing products aimed at markets worth at least
$250 million in annual sales. The ideal market for a new drug is one that is both large and underserviced.
While an effective treatment for Alzheimers disease would be a substantial breakthrough and achieve blockbuster status overnight, it's hard to get excited about yet another hypertension
drug, Mr. Sturza says.
Another key factor in a drug's success is how frequently it's likely to be prescribed. Drugs that are used to treat chronic conditions -- the afflictions related to aging or AIDS -- will
generate a lot more cash flow than infrequently used treatments like vaccines.
Yeah, but does it work?
All the due diligence and strategy in the world will mean squat if the drug your company is developing doesn't work. How much hard science you insist on depends in great measure on
your risk tolerance.
The standard development process for a drug starts with preclinical work. Then come Phase I trials, which focus on whether the drug is safe for humans. Phase II looks at the drug's
effectiveness. And Phase III is a wider, more rigorous test of the Phase II results. If Phase III results are successful, the product is submitted to government regulators for approval.
Generally, analysts advise against paying much, if anything, for the shares of the companies involved in preclinical work only. Positive results in Phase I should be taken with a boulder of
salt because they tell very little about a drug's potential effectiveness in treating a disease.
Ms. Huang says she's not comfortable with a company until she's seen at least positive interim results form Phase II trials. In addition, she looks for the results of the research to be
published in reputable, peer-reviewed journals.
Mr. Sturza says that over the past six years, he has recommended only one company involved in Phase I trials. A caveat, says Mr. Lwowski, is when the company's underlying
technology is compelling enough to warrant early investing, as with a company like Micrologix Biotech.
Don't fall asleep at the wheel.
Like junior mining stocks, biotechnology require more diligence than most investments because events can move quickly against you. There are a number of things to look for that may
indicate all is not well in the lab.
Insider selling: While the sale of stock by insiders could mean something as innocuous as estate planning, it generally shouldn't be considered a strong vote of confidence in your
company's prospects.
1.Delays in clinical trials or regulatory filings: Be wary of companies that miss self-imposed deadlines. If they say Phase III trials will begin in May and nothing's happened by
Christmas, it may be a sign of serious problems. Stocks generally get clobbered by delays, a way of discounting the increased risk. Hemosol Inc. shares are now trading for about
half what they were when the company announced delays in the start of Phase II trials last January for Hemolink, its human blood substitute.
2.Sudden changes in research focus.
3.Sudden departures of key senior officials.
4.Inability to secure a marketing partner.
The bottom line: Biotechnology stocks are best suited for risk-tolerant investors seeking above-average capital gains.
Having said that, there are ways to remove some of the risk from your portfolio, starting with good research and followed by continued diligence.
You can also balance potential risks and rewards by deciding when to invest in development-phase companies. The biggest returns and risks come from getting into companies in
preclinical trials, while the most secure investments are in companies that are well into clinical trials with strong marketing alliances. The upside, however, may be limited. |
